DE-SPRAWLING THE BURBS

Developers of mixed-use projects are following a solidly established American migration pattern: treading the highways that sprout from urban city centers into the suburbs. Unlike previous migrations, however, this trek isn't an escape from cities, but an ambitious move to export an old-time downtown look and feel to suburbia, from Main Street storefront display windows set in brick facades to dense housing stacked above shops.

Soaring energy prices and rising land costs are only hastening the concept's momentum. By combining retail, residential and office uses, the projects not only create walkable live-work-play environments long-envisioned by new urbanism proponents, but they also become destinations for surrounding communities.

Rising construction costs pose about the only threat to slow the suburban mixed-use development trend, but so far even those speed bumps have failed to deter investors and developers. Who are these pioneers? They're largely longtime commercial real estate professionals who until a few years ago spent most of their time building stand-alone retail or apartment projects.

Case in point: St. Petersburg, Fla.-based Sembler Co. spent some four decades developing millions of square feet of retail projects — from strip and power centers to grocery-anchored neighborhood centers — in the Southeast and Puerto Rico. But early this decade, the company delved into the mixed-use concept and has opened four projects in suburban Atlanta over the last year, including the $165 million Perimeter Place.

The project is anchored by a Super Target and includes 425,000 sq. ft. of retail and office space, and more than 550 residential units above shops and in separate properties within the project's 42 acres. Perimeter Place also possesses the ideal location and demographic characteristics mixed-use developers want most: It sits near a major interstate and an Atlanta transit system station.

Some 414,000 residents live within seven miles of the project and have average annual household incomes of more than $99,000. According to market researcher Claritas, the national average is $65,000.

Today, Sembler has six additional suburban mixed-use projects under construction totaling more than 3 million sq. ft. in the Southeast, including Winter Garden Village in Florida. That project will feature 1.15 million sq. ft. of commercial space and some 300 town homes. Going forward, mixed-use properties will make up about half of Sembler's developments, says Jeffrey Fuqua, president of development for the company.

Still, he says, tackling mixed-use initially created much unease. “We were virtually entering the world of the unknown,” Fuqua says, referring to the notion of adding housing to its retail projects. Sembler was unfamiliar with residential construction as well as the industry's cyclical nature. Residential developers Lincoln Property Co. and Southeast Capital Partners developed the lion's share of apartments and condos at Perimeter Place.

But now Sembler has 7,000 housing units planned or under construction in mixed-use projects. In March, the company launched a division to bring residential development in-house. “Now we're extremely comfortable with mixed-use,” Fuqua adds, “and our favorite projects are those that have a residential component to them.”

Synergy maximizes value

So what's the mixed-use attraction? Sembler's Perimeter Place and other successful mixed-use projects are generating cash-on-cash returns of about 9%, which is generally in line or a little higher with standard retail projects. Private equity investors, meanwhile, expect mixed-use to provide an internal rate of return (IRR) of more than 15% over five to seven years.

Unlike urban mixed-use, which generally features retail, housing and offices in one large structure, suburban mixed-use projects may span blocks and feature big-box retailers as well as town homes, or single-family housing, on the fringes of the commercial activity. For-sale housing properties, as well as condos above shops, can quickly return capital to developers, enabling them to pay down construction debt that typically finances about 75% of a suburban mixed-use project.

Thus, with less debt to refinance later, investors can reap even greater returns on the residual equity, says David St. Pierre, a founder and principal of Lyndhurst, Ohio-based Legacy Capital Partners. The private equity advisory firm is seeking to fund mixed-use development in urban and suburban areas.

Additionally, developers can charge a premium for space in suburban mixed-use projects, particularly for housing. Apartments in Birkdale Village, a mixed-use development completed in 2002 in suburban Charlotte, N.C., fetched rents that were at least 15% above the market, says Todd Mansfield, CEO of Birkdale Village developer Crosland Inc.

The longstanding Charlotte-based real estate developer primarily had built stand-alone shopping centers and apartments before taking on Birkdale Village, which includes 300 apartments and 285,000 sq. ft. of office and retail. “The real upside value in mixed-use projects is in the residential component,” explains Mansfield. Crosland sold Birkdale Village to Inland Realty for 25% above cost in 2003.

Mixed-use developers often target sites at or near public transit stations. They're razing strip centers, office buildings or other tired buildings to be in proximity. Sembler razed two office buildings to make way for Perimeter Place, which it co-developed with Greensboro, N.C.-based Stephen D. Bell & Co., a multifamily and commercial property developer.

Perimeter Place is 98% leased, Fuqua reports, and Sembler has bumped up triple-net asking rents in some remaining small-shop space to about $35 per sq. ft., some $5 a sq. ft. over the market rate for similar space. Although residential renters and buyers generally aren't paying a premium for housing in Perimeter Place, Fuqua says, the units have rented or sold faster than homes outside the project.

“Residential is already so competitive and on the verge of being overbuilt in this area,” he says. “But it's the mixed-use projects that have a special story to tell that make residential development viable.”

Birth of an asset class

The suburban mixed-use phenomenon has emerged so quickly that no data on how much development is taking place exists, though national real estate organizations are trying to get a handle on the proliferation. The International Council of Shopping Centers, Building Owners and Managers Association, National Multi Housing Council and others have started analyzing the properties to prepare for a landmark mixed-use conference in Hollywood, Fla., on Nov. 16-17.

Much like Sembler, developers such as Crosland and Denver-based Continuum Partners have latched onto the mixed-use concept and are making these developments their primary focus. Continuum Partners is about halfway finished with its ambitious $800 million Belmar downtown district in Lakewood, Colo., near Denver. The project spans 22 blocks (see sidebar on p. 32).

Continuum also is pursuing mixed-use projects in other suburban Denver neighborhoods, including Belleview Station, an 18-acre project slated for a former golf course in southeast Denver. The project will surround the future Belleview Station light rail center and will include 1,900 residential units, 600,000 sq. ft. of office and 200,000 sq. ft. of retail space. The groundbreaking is expected to take place next spring, and hotels are planned for later phases of the development.

“Our goal is to do projects of significant scale a handful at a time,” says Tom Gougeon, chief development officer and principal of Continuum. “Mixed-use is pretty much what we do — we're not too much into other kinds of development.” Gougeon expects mixed-use projects to generate an IRR between 12% and 15%.

Warning signs

The question of how long mixed-use developers will be able to build these projects looms large. Rising construction costs are forcing developers tore-evaluate projects, or halt plans. Legacy Capital, which raised $44 million in 2004, pursued a mixed-use project in a smaller Florida market. But construction bids were 30% over what the developer and private equity partners expected, which has delayed the project, says St. Pierre.

Still, Legacy Capital's pursuit of mixed-use developments marks a shift from its initial goal of hunting down stand-alone development. And though the company has yet to finance a mixed-use deal, St. Pierre says the firm has several potential developments in the pipeline and is planning to launch an additional fund of $75 million to $100 million specifically targeting mixed-use projects.

But Legacy Capital hopes to feed off the residential demand mixed-use developments create, even if the company is not a partner in the core project. In suburban Cleveland, for example, Legacy Capital is financing development of 116 town homes near Crocker Park, a 75-acre mixed-use undertaking. “Development today is being driven by creating higher density,” St. Pierre says. “Land costs are getting more expensive, and municipalities don't want an under utilized project of single-story retail.”

The higher-than-expected construction costs have also stung Crosland executives, who are reworking the economics of its planned $140 million Town Square at Biltmore Park project in Asheville, N.C. Grading started in July on the project, but final construction bids came in 10% above the budget, Mansfield says.

The development, set on farmland once part of the Vanderbilt estate, will include 440,000 sq. ft. of office and retail space, more than 300 apartments and condos, and a hotel site.

A big part of Town Square's cost increase stems from the rise in concrete prices this year. The 42-acre site's constraining hilly terrain requires Crosland and its partner, land owner Biltmore Farms, to build parking garages that cost six times as much as surface parking in normal construction environments.

The additional expense could drop returns by about one percentage point. But Mansfield expects to close the cost gap by tweaking the Town Square plan. “This project is still compelling,” says Mansfield, whose firm has completed a handful of suburban mixed-use projects since opening Birkdale Village. “We haven't seen a project canceled or stopped, but construction costs are putting a lot of pressure on them.”

Complex challenges

Beyond escalating construction costs, developers must address complexities not present in stand-alone projects. Property uses have different lease-up and stabilization time frames, which may require developers of single-use projects to adjust their expectations.

Combining different uses under one roof presents many challenges, from design to property management. When putting housing atop stores, often that means stacking a wooden-framed structure above a steel-framed structure. The projects must include separate entrances for office, retail and residential users.

Plus, adds Mansfield, in some cases developers need to take potential management problems into account when designing projects. People excited about living on a vibrant Main Street with restaurants or clubs operating late at night may quickly tire of the environment. Crosland prefers stacking apartments rather than condos above shops. “It's a lot easier to satisfy an apartment renter than it is a condo owner in that situation,” he says.

Growing acceptance

Potential pitfalls have failed to slow the momentum of suburban mixed-use up to this point. Some parts of the development process have become easier, say experts. Lenders have warmed up to suburban mixed-use considerably over the past five years because the assets have an established track record of performance.

But debt providers still want developers who have expertise in the products, whether that stems from retail relationships, construction experience, or working with governmental agencies to finance complex projects, says Sam Kirschner, head of origination for Hypo Real Estate International. Plus, he adds, lenders are scrutinizing the locations for attractive demographics and want to see a location that needs new housing, retail, or both.

Denver-based private equity firm Amstar Group and Franklin, Tenn.-based developer Southern Land Co. believe they've found just such a site in the suburban Nashville community of Cool Springs. That's where the partners are developing McEwen Place Town Center, a mixed-use project that will feature 300,000 sq. ft. of retail, 300,000 sq. ft. of office space and 900 residential units.

Average household income in a 10-mile radius around the proposed center is $107,000, and the development is located across the street from Nissan's new North American headquarters. The car company is moving to Cool Springs from Los Angeles and is expected to complete the $70 million building in 2008.

“Mixed-use is a growing trend across the U.S.,” says Brad Broyhill, executive director for multifamily investments at Amstar. “But when you've got this kind of growth corridor, it's a very unique opportunity.”

Joe Gose is a Kansas City-based writer.

MAJOR MIXED-USE PROJECTS IN THE PIPELINE

Dense mixed-use projects are springing up in the suburbs. Here is a sampling of projects planned or under construction.

Belmar: The newest downtown in Colorado

When Continuum Partners set its sights on redeveloping the landmark 35-year-old Villa Italia mall in Lakewood, Colo. five years ago, the developer aimed to create a dense mixed-use center in the community west of the Mile High City.

The fact that the 1.4 million sq. ft. mall was failing didn't bother Continuum's executives, who liked the site. When they looked across the street and saw Lakewood's city hall, library and cultural center, they warmed up to it even more.

“You had what essentially were all the functions of a downtown grouped together,” recalls Tom Gougeon, chief development officer and principal of Continuum. “But there was no downtown.”

Now there is. Known as Belmar, Continuum's grand $800 million mixed-use project is taking shape across 22 square blocks in Lakewood, which has a population of some 145,000. Belmar opened in 2004, and Continuum has completed about half of the project. When built out over the next five years, Belmar will total 2 million sq. ft. of retail space and offices, 1,300 residential units, and a hotel. Parks and other public gathering spaces are interspersed throughout the shops, offices and housing.

Thus far, Belmar features 660,000 sq. ft. of retail and restaurants anchored by a Whole Foods, 16-screen Century movie theater and Dick's Sporting Goods. The developer has finished 300 residential units split between condos, apartments and town homes. Some 900 more residential units will be delivered in 18 months

One surprise: 215,000 sq. ft. of fully occupied office space in a metro market suffering from a vacancy rate of 19%, reports Reis Inc. Before Belmar, Lakewood wasn't known as an office market.

Now the community is studying how to link to a light rail station about a mile away as Denver undertakes a $4 billion transit expansion. The likely connection route: A 200-foot wide right-of-way reserved for a parkway that never materialized leads to the station from Belmar.

“There are certain places that want to be the center of gravity and that want critical mass,” Gougeon says. “I don't think you can go out and create this on just any corner just because you want to.”— Joe Gose